How does our monetary system work?

📘 In Brief Our monetary system is based on the principle of trust and debt. Most of the money we use daily is not physical cash, but digital book money created by commercial banks. When a bank issues a loan, it simply credits the borrower’s account – the money is thus created out of nothing, as a debt owed to the bank. However, this newly created money is tied to a repayment obligation. The borrower owes the bank the loan amount plus interest. The central bank (e.g., the ECB) controls this system by setting the key interest rate and regulating the money supply. It is the only institution allowed to actually print new central bank money, which then serves as reserves for commercial banks. At its core, our system functions as a cycle of trust: we trust that our money will still hold the same value tomorrow, and banks trust that loans will be repaid. This trust is the actual currency – if it breaks, as in a financial crisis, the entire system collapses because money is based only on promises, not on real values like gold. 🔍 Why This Matters The monetary system is based on the principle of fiat money: money has no intrinsic value but derives its value from state authority and the trust of its users. Central banks control the money supply by providing central bank money to commercial banks and influencing lending through the key interest rate. Commercial banks create most money as book money through lending: when a bank issues a loan, a deposit is created in the borrower’s account without any previously saved money needing to exist. This money creation is limited by capital and minimum reserve requir …